Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 90 C 999 Ruben Castillo, Judge.
Before POSNER, Chief Judge, and KANNE and EVANS, Circuit Judges.
This is a class action on behalf of persons who sold either common stock of Allegis Corporation (now UAL Corporation) or puts in common stock of Allegis between October 29 and December 8, 1987. The plaintiffs complain that Allegis defrauded them, in violation of Rule 10b-5 of the Securities and Exchange Commission, by concealing information that if revealed would have caused the price of the stock to rise during the complaint period. There are other charges but they need not be discussed separately. The district judge granted summary judgment for the defendant.
There is a threshold question: whether the sellers of puts, or other options, are (as the district judge held) within the class of investors protected by Rule 10b-5. If not, they should have been dismissed from the suit without consideration of the merits of their claim that they were defrauded along with the owners of the stock.
A put entitles the holder to sell a specified security by a specified delivery date at a specified price (the "strike price") to the seller of the put. The buyer hopes that the price of the security will fall between the date of the contract and the date of delivery so that he can buy it at a price lower than the strike price, the price at which the seller of the put is obligated to purchase the stock if it is tendered. The seller of the put, conversely, hopes that the price of the security will stay above the strike price, for then the buyer will not exercise his option and the seller will have a profit equal to the price at which he sold the put. If the market price falls below the strike price, the seller of the put will lose the difference between those two prices (minus the price of the put itself). See Richard A. Brealey & Stewart C. Myers, Principles of Corporate Finance 486-88 (4th ed. 1991).
So sellers of puts during the complaint period (whether the original writers of the puts or sellers in the secondary market), when the price of Allegis stock is alleged to have been artificially depressed, should have been happy rather than sad when the price jumped back up, as distinct from sellers of the stock itself, who lost this profit if they sold their stock during the period of depressed prices, and writers of puts before the complaint period (clearly not members of the plaintiff class), who may have had to honor the puts during the complaint period, when the price of the stock was depressed. The plaintiffs seem not to understand that stock and put prices move inversely to each other. But the defendant makes nothing of this, so we shall swallow our doubts and assume that some of the options traders whom the complaint, perhaps inaccurately, calls sellers of puts were hurt.
Puts and other stock options are securities within the meaning of the Securities Exchange Act, 15 U.S.C. sec. 78c (a)(10); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 750-51 (1975), but they are not necessarily (or in this case) securities issued by the corporation that issued the underlying securities, the subject of the option contracts. For the proposition that Rule 10b-5 does not make the issuer of the underlying securities responsible for the effects of a securities fraud on the owners of options on those securities, the defendant cites Laventhall v. General Dynamics Corp., 704 F.2d 407, 412-14 (8th Cir. 1983). The leading case in favor of issuer's liability is Deutschman v. Beneficial Corp., 841 F.2d 502, 506-07 (3d Cir. 1988); see 8 Louis Loss & Joel Seligman, Securities Regulation 3601 and n. 360 (3d ed. 1991). The objection to liability is that the extent of harm to the option holders depends on factors beyond the control of the issuer of the underlying securities, including the number of options and the terms of the option contracts.
The division of authority is illusory. Laventhall was an insider-trading case. The decision against liability turned on the fact that a corporation has no fiduciary obligation to option traders, as it does to its own shareholders. The existence of fiduciary obligation was critical because insider trading is the abuse of a fiduciary position, Chiarella v. United States, 445 U.S. 222 (1980), rather than out-and-out fraud, that is, fraud accomplished by misrepresentations (or, what amounts to the same thing, misleading omissions). The duty not to make misrepresentations does not depend on the existence of a fiduciary relationship. Basic, Inc. v. Levinson, 485 U.S. 224, 240 n. 18 (1988); Elizabeth M. Sacksteder, Note, "Securities Regulation for a Changing Market: Option Trader Standing Under Rule 10b-5," 97 Yale L.J. 623, 641 (1988). If it did, very little fraud would be actionable. The garden-variety fraud in which the seller of a product misrepresents its qualities to the buyer would not be, because a seller is not his buyer's fiduciary.
So the case law provides no support for the defendant's position. And since fraud (whether it takes the form of a misrepresentation or of an abuse of a fiduciary position) is a deliberate wrong, the considerations that lead courts to limit the scope of liability for accidental wrongs to consequences that are in some sense "foreseeable" are not in play. Option traders play an important role in maintaining the efficiency of the securities markets, moreover, so they have a claim to protection against being defrauded.
Two arguments can be made against liability to options traders. First, since it is very difficult to see how they can be hurt by a securities fraud without the owner of the optioned securities being hurt, a more limited liability should be sufficient to deter most securities frauds. Second, it is very difficult for the corporation that issued the underlying securities to gauge its potential liability for a securities fraud if options traders are within the protected class. We have to worry about the danger of overdeterrence because, while securities fraud is nominally a species of deliberate wrongdoing, the doctrines of securities law and particularly the application of those doctrines to particular factual situations are so difficult, complex, and uncertain that there is a serious danger of erroneous impositions of liability.
But these two Rubicons were crossed when short sellers were held to have standing to sue under Rule 10b-5, Zlotnick v. TIE Communications, 836 F.2d 818, 821 (3d Cir. 1988); cf. United States v. Russo, 74 F.3d 1383, 1392 (2d Cir. 1996), a holding that we do not understand the defendant to question. The corporation has no control over the number of its shares that are shorted -- the number may in fact exceed the total number of outstanding shares, Sullivan & Long, Inc. v. Scattered Corp., 47 F.3d 857, 859 (7th Cir. 1995) -- or over its potential liability, which is the difference between the price of the short sale and the (higher) market price when the short seller has to cover. The potential liability to short sellers is thus greater than that to either the buyers of puts, who can lose only the price they have paid for the put, or the sellers of puts, who can lose only the difference between the strike price and a lower market price (but not lower than zero of course), minus the price of the put. Only the writer of a call, who like a short seller agrees to sell stock to the buyer at the strike price, obliging the writer of the call to buy stock (unless he owns it already) at the market price -- however high it goes -- if necessary to honor the call, has as much exposure to loss as a short seller.
We don't, strictly speaking, have to resolve the issue of the right of buyers of puts, or other option traders, to sue under Rule 10b-5. We described it as a threshold issue but it is not jurisdictional. It has nothing to do with "standing" in the Article III sense; the buyers were harmed as a consequence of the defendant's conduct and would be helped if the relief they seek is granted. It is true that when Congress makes clear that a statute is not intended to confer rights on a particular class of persons, a suit under the statute by a member of that class does not engage the jurisdiction of the federal courts, Merrell Dow Pharmaceuticals Inc. v. Thompson, 478 U.S. 804, 814 (1986), so that the court must dismiss it even if neither party notices the problem, just as if there were no standing in the Article III sense. But if the scope of the statute is unclear, the question whether a particular class is protected by it becomes just another issue concerning the merits of the suit and therefore one that the court need not decide if, as we shall see is the case here, another issue is fully dispositive. This is ...